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Idiosyncratic risk and the equity premium: evidence from the Consumer Expenditure Survey

  • Timothy Cogley

This paper uses household consumption data to investigate whether uninsurable idiosyncratic risk accounts for the equity premium. The analysis complements and extends prior empirical work by relaxing maintained assumptions about idiosyncratic income shocks. Following Mankiw (1986), the paper develops an equilibrium factor model in which risk premia depend on the covariance between an asset's return and certain moments of the cross-sectional distribution for consumption growth. Cross-sectional consumption factors are constructed using data from the Consumer Expenditure Survey, but they do not appear to be promising candidates for explaining the equity premium. Cross-sectional factors are very weakly correlated with stock returns, and generate equity premia of 1.5 percent or less when preference parameters are set at plausible values.

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Paper provided by Federal Reserve Bank of San Francisco in its series Working Papers in Applied Economic Theory with number 98-07.

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Date of creation: 1998
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Handle: RePEc:fip:fedfap:98-07
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  1. Stephen P. Zeldes, . "Consumption and Liquidity Constraints: An Empirical Investigation," Rodney L. White Center for Financial Research Working Papers 16-88, Wharton School Rodney L. White Center for Financial Research.
  2. Weil, Philippe, 1989. "The equity premium puzzle and the risk-free rate puzzle," Journal of Monetary Economics, Elsevier, vol. 24(3), pages 401-421, November.
  3. Duffie, Darrell & Huang, Chi-fu, 1986. "Multiperiod security markets with differential information : Martingales and resolution times," Journal of Mathematical Economics, Elsevier, vol. 15(3), pages 283-303, June.
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  6. Nelson, Julie A, 1994. "On Testing for Full Insurance Using Consumer Expenditure Survey Data: Comment," Journal of Political Economy, University of Chicago Press, vol. 102(2), pages 384-94, April.
  7. N. Gregory Mankiw, 1986. "The Equity Premium and the Concentration of Aggregate Shocks," NBER Working Papers 1788, National Bureau of Economic Research, Inc.
  8. Heaton, John & Lucas, Deborah J, 1996. "Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing," Journal of Political Economy, University of Chicago Press, vol. 104(3), pages 443-87, June.
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  10. Kent D. Daniel & David A. Marshall, 1998. "Consumption-based modeling of long-horizon returns," Working Paper Series WP-98-18, Federal Reserve Bank of Chicago.
  11. Attanasio, Orazio P & Weber, Guglielmo, 1995. "Is Consumption Growth Consistent with Intertemporal Optimization? Evidence from the Consumer Expenditure Survey," Journal of Political Economy, University of Chicago Press, vol. 103(6), pages 1121-57, December.
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  16. Attanasio, Orazio & Davis, Steven J, 1996. "Relative Wage Movements and the Distribution of Consumption," Journal of Political Economy, University of Chicago Press, vol. 104(6), pages 1227-62, December.
  17. Lucas, Deborah J., 1994. "Asset pricing with undiversifiable income risk and short sales constraints: Deepening the equity premium puzzle," Journal of Monetary Economics, Elsevier, vol. 34(3), pages 325-341, December.
  18. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  19. Angus Deaton & Christina Paxson, 1993. "Intertemporal Choice and Inequality," NBER Working Papers 4328, National Bureau of Economic Research, Inc.
  20. Constantinides, George M & Duffie, Darrell, 1996. "Asset Pricing with Heterogeneous Consumers," Journal of Political Economy, University of Chicago Press, vol. 104(2), pages 219-40, April.
  21. Cochrane, John H, 1991. "A Simple Test of Consumption Insurance," Journal of Political Economy, University of Chicago Press, vol. 99(5), pages 957-76, October.
  22. Daniel, Kent & Marshall, David, 1997. "Equity-Premium And Risk-Free-Rate Puzzles At Long Horizons," Macroeconomic Dynamics, Cambridge University Press, vol. 1(02), pages 452-484, June.
  23. John H. Cochrane & Lars Peter Hansen, 1992. "Asset Pricing Explorations for Macroeconomics," NBER Working Papers 4088, National Bureau of Economic Research, Inc.
  24. Kocherlakota, Narayana R, 1990. " Disentangling the Coefficient of Relative Risk Aversion from the Elasticity of Intertemporal Substitution: An Irrelevance Result," Journal of Finance, American Finance Association, vol. 45(1), pages 175-90, March.
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